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Digging Deep for Value- Avalon (AWX) and Gravity (GRVY)

While I have some time in between jobs, I’ve decided to spend a little more time researching small cap stock opportunities (market cap under $100 million). I’m going to pick around 5 of these companies to invest in, and they will be a VERY SMALL portion of the overall allocation given my inexperience in stock-picking these types of companies and their inherent risk. Below are my first picks. They both have the unique trait of a net asset value (assets minus liabilities) that is significantly greater than the market value of the entire company. In theory, if you were to buy the companies at their current market cap, immediately shut down both companies today and sell off the assets, you would bank a sizable profit. In reality they are cheap and probably fairly valued at current levels for a reason!

Gravity Co, Ltd. (GRVY). This is a South-Korean based online gaming company that went public on Nasdaq in 2005 at around $13.50 per share. At the time they had some wildly popular online games (namely Ragnarok) that attracted over 40 million users worldwide, but internal corruption/ lawsuits, divestitures, and declining success of their latest game releases has led their gradual drop to around $1.00 per share since the beginning of this year ($31 million mkt cap). Their cash bleed in the past 12 months has been around $6 million.

Foreign micro-cap, declining revenues/ losses, and no visibility into positive earnings in the near future- yes, that’s some bad news and not worth risking much dough on. The good news, however, is that as of 9/13, Gravity had approx. $63 million of current assets (of which $50 million is cash/ short term investments). If you offset this against their total liabilities of $18 million, you are left with a net value of $45 million, compared with a current market cap of $31 million. That’s $14 million of cushion on top of valuing Gravity’s non-current assets (PP&E, intangibles, etc.) and their business at a $0 value.

I realize this is a very risky play, but they still have revenues coming in from their legacy games, several hundred employees working hard to come up with new games/ revenue streams on tablets and mobile, and ample cash to try and stop the bleeding. Plus, I was in a band called “Gravity” (see picture up top), so perhaps it was destiny for me to take a flier on this one 😉

Avalon Holding (AWX). This is an interesting company. They have two primary business segments (i) waste management/ landfill services and (ii) ownership/ operation of three golf courses and associated recreational facilities at the Ohio/ Pennsylvania border. Unlike Gravity, Avalon’s stock price has risen substantially in the past year (from a low of $3.50 per share to around $5.50 today), due to significant increases in their operating income from waste management operations as compared to a year ago, as well as additional revenue sources and wealth creation in the Ohio/ Pennsylvania corridor attributable to the shale gas boom. They have also upgraded one of their courses (Avalon Lakes), which is fully operational after an $8 million renovation and $150 green fees. Net operating income for the waste management division through September was $2.9 million compared with $2.2 million as of September 2012. The golf course operations have been breaking even the last few years.

Avalon’s current market cap is around $21 million, representing a 0.53 price to book value. While most of their asset value is non-current (i.e. the three golf courses they own), there is a significant cushion between net assets (total assets minus liabilities) of approx. $40 million and a current $21 million market cap. This amazes me in that it looks like Avalon will be profitable this year with no significant capital exposure as far as I can tell. The reported asset value of their three golf courses and related facilities (which look nice from I can tell on the website and include a Pete Dye designed course) are $30 million by themselves. There has got to be something here that I’m missing, because it seems like an investment in Avalon represents a stake in the promising waste management business where they are experiencing material revenue growth, with three golf courses and recreation facilities basically thrown in for free. My understanding is that the chairman/ founder owns a controlling 67% stake, which may partially account for the huge discount, but from what I’ve read he’s been prudent about executive comp and growing the business.

If it sounds too good to be true, it usually is, so I would love any input from readers out there who think I’d be crazy to put up a small bet on these two companies. In the meantime I’m long Avalon and the laws of Gravity.